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China Currency ETFs: Slow and Steady Growth In 2012?

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The Chinese economy is the world’s second largest economy and a key driver of the global economic growth. It amounts to over 10% of world GDP and about 25% of world GDP growth. Given China’s importance in the global economy, it appears inevitable that its currency will become a reserve currency like the Dollar and the Euro, sometime in future.

Earlier this week, the IMF head stated that Yuan (also known as Renminbi) could become a global reserve currency if China implemented market-oriented changes including flexible exchange rate system, well-developed financial markets and opening up of the capital account. While China has been slowly loosening controls on capital flows, its financial markets and exchange rate system still remain very tightly controlled. (Read: The Guide to China Bond ETFs)

It has been general belief that China manipulates its currency to keep it at artificially low levels in order to support its exports. In July 2005, China removed its decade-old peg to the dollar, revalued its currency by 2.1% and moved to reference to a basket of currencies of its major trading partners. The currency has appreciated roughly 30% against the Dollar since then. China pegged the currency to the Dollar again in 2008 but returned to basket based approach in July 2010. While the currency appreciated 5% against the Dollar in 2011, it has remained largely unchanged this year.

Recently the World Bank released a report co-authored with a Chinese cabinet think tank (State Council’s DRC) that outlined some critical reforms needed in China’s financial markets for maintaining its growth rate. The fact that the report had official endorsement implies that the Chinese political leaders are aware of the necessity to implement reforms. But as the country prepares for big leadership transition later this year, the reforms may not come anytime soon. (Read: What Bubble? China ETFs Soaring to Start 2012)

Further, China's capital-intensive and export-oriented economy is already facing strong headwinds due to economic conditions in its major export markets. Economists expect China's annual economic growth to slow to close to 8% in the first quarter of 2012, down from 8.9% in the last quarter of 2011. That would be the fifth successive quarter of slower growth and China is likely to end this year with its weakest expansion in a decade.

Last month, China reported its biggest monthly trade deficit since 1998, with imports exceeding exports by $31.5 billion. Given the state of economy, the People’s Bank of China is far more likely to try and keep the Yuan from rising significantly in the next few months. (Read: Forget FXI, Try These Three China ETFs Instead)

Even if appreciation in the currency is expected to be moderate, there remains significant attraction in establishing exposure to the currency of world’s second largest economy and the Yuan currency ETFs present a great way to playing the growth in China.

CYB aims to achieve total returns reflective of both money market rates in China and changes in value of the Chinese Yuan relative to the U.S. dollar. The Fund, which was launched in May 2008, invests in a combination of U.S.money market securities and forward currency contracts and swaps. It also invests in money market securities and other instruments, including forward currency contracts and swaps, denominated in Chinese Yuan that trade and settle in Hong Kong and other markets outside of mainland China. In terms of asset groups, T Bills occupy the heaviest weight at 59.5%. Repos and time deposits follow with 21.7% weight and 18.3% weight respectively.

The fund had returned 0.52% year-to-date and charges an expense ratio of 0.45%. The fund however had an attractive distribution yield of 2.19%, as of the end of last quarter of 2011. Since inception, it had total returns of 7.26% and currently manages assets worth $395.6 million.

Started in March 2008, this fund with AUM at $77.7 million seeks to replicate, net of expenses, the S&P Chinese Renminbi Total Return Index. The index tracks the value of the Chinese currency relative to the U.S. dollar. It follows the value of non-deliverable, three-month currency forward contracts that are rolled at three-month intervals and includes daily accrued interest. The ETNs are senior unsecured debt obligations of Morgan Stanley. The fund charges 0.55% to the investors and has returned negative 0.15% year-to-date.

FXCH, which made its debut in October last year, seeks to track the price of Renminbi, plus any accrued interest. The depository for the trust maintains an account denominated in the Chinese currency. The interest earned is used to pay the expenses and the any excess interest in distributed to the shareholders. The fund charges 0.40% annually to the investors and has returned 0.15% year-to-date. It has so far attracted assets worth $7.9 million.

FXCH provides investors with direct exposure to the Yuan without using derivatives and is backed by the underlying currency, held in deposit accounts. On the other hand, CYB and CNY mostly use non-deliverable forward currency contracts to gain exposure to the currency (CYB also invests in some Yuan denominated money market instruments). As the Chinese currency is rather stable, future appreciation is usually already priced into the forward contracts, which results in these two ETFs lagging the currency. FXCH on the other hand, is more likely to closely track the currency.

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